Dynamic Hedging Strategy

Thesis

The dynamic hedging strategy described below utilizes deep out of the money PUT options on the S&P 500 or SPY. The purpose of the trade is to provide low cost continuous portfolio protection from severe declines generally speaking of 20% or greater. Broadly speaking The algorithm is designed to maximize pay off during catastrophic events while minimizing impact during fairly normal conditions.

Backtest Resutls

The back tested results below make the following assumptions:

1. The client's portfolio tracks the S&P 500 perfectly.
2. The client spends 100% of the dividends received on the execution of the Options overlay.
3. 100% of excess cash is reinvested into the market immediately and at the market price.
4. Options are rolled monthly based on the algorithm
5. Stock is never sold from the portfolio.
6. The options overlay is kept on continuously regardless of market conditions.

Trade Profile

The options overlay utilizes the inherent convexity in options created by the different impact time has on various options chains, as well as the particularly high levels of uncertainty baked into the prices of deep out of money options to create a trade a J like payout profile whereby the client accepts all normal losses but begins to first recover rapidly and then make money in the event of an extreme decline.